Dear CIGAs,

Over the past 12 weeks, between July 22, 2011, and October 14, 2011, the FDIC closed 25 banks, bringing to 80 this year’s total.  All together, these 25 banks had reported assets of $10.77 billion and deposits of $9.37 billion.  Their failures cost the FDIC an estimated $2.05 billion, about 22% the value of deposits.

The 80 banks that have failed this year had reported assets totalling $32.83 billion and deposits of $29.11 billion.  Their failures cost an estimated $6.6 billion, about 23% of deposits.  These failures serve to remind us that the problem of troubled banks remains alive and well.

Bank Failures Provide Rare Glimpse Into True Asset Values

Each new bank failure also reveals key information regarding misleading financial reporting throughout the U.S. banking sector.  That is because figures disclosed by the FDIC in connection with each closing allow a glimpse into how dramatically bank assets are permitted to be overvalued under present accounting rules.

The true value of bank assets has been murky ever since April 2009, when the Financial Accounting Standards Board (“FASB”) repealed fair value accounting requirements.  Fair value requirements compelled banks and other financial companies to value their less liquid assets at prices approximating what they could actually be sold for in the open market.

FDIC Has To Estimate Fair Value

When any bank fails, the FDIC releases a statement that includes its estimated cost of protecting the bank’s depositors.  That estimate is based upon what the FDIC has determined, or reasonably believes, a third party is willing to pay for the failed bank’s assets.  That is very similar to what banks were required to do prior to the FASB’s repeal of fair value requirements.

Each failed bank’s liabilities are primarily the amounts it owes to its depositors.  It may have additional liabilities, but those are not the FDIC’s problem.  Therefore, if you subtract the FDIC’s estimated cost of protecting each bank’s deposits from the amount of those deposits, you get an idea of what the FDIC believes it will net from the sale of the bank’s assets.

Extent of Overvaluation is Staggering

On paper, the 25 banks that failed over the past 12 weeks had assets reported to be worth $10.77 billion.  Collectively, those banks had deposits of $9.37 billion.  The FDIC estimated its cost of protecting those deposits to be $2.05 billion.  That means the FDIC believes it will net $7.32 from selling off all the failed banks’ assets.  By this estimate, management overstated the value of the banks’ assets by $3.45 billion, or 47%.

Applying this analysis to specific bank failures announced over the past 12 weeks yields some staggering examples.

Patriot Bank of Georgia of Cumming, GA had assets reported to be worth $150.8 million that are now estimated to be worth only $66.9 million, an overstatement of $84 million or 126%.

Sun Security Bank of Ellington, MO had assets reported to be worth $355.9 million that are now estimated to be worth only $172.1 million, an overstatement of $183.8 million or 107%.

Country Bank of Aledo, Illinois had assets reported to be worth $190.6 million that are now estimated to be worth only $101.2 million, an overstatement of $89.4 million or 88%.

Piedmont Community Bank of Gray, GA had assets reported to be worth $201.7 million that are now estimated to be worth only $109.8 million, an overstatement of $91.9 million or 84%.

Lydian Private Bank of Palm Beach, FL had assets reported to be worth $1.7 billion that are now estimated to be worth only $947 million, an overstatement of $753 million or 80%.

BankMeridian, N.A. of Columbia, South Carolina had assets reported to be worth $239.8 million that are now estimated to be worth only $150.1 million, an overstatement of $89.7 million or 60%.

Bank of the Commonwealth of Norfolk, VA, had assets reported to be worth $958.1 million that are now estimated to be worth only $633.5 million, an overstatement of $351.6 million or 56%.

Overvaluation Likely Among All U.S. Banks

There is good reason to believe that this extent of overvaluation is not limited to these specific failed banks.  Prior to their closure, 21 of the 25 banks being discussed here had been operating subject to very stringent enforcement orders imposed by their federal regulators.

That means that for a considerable time, federal regulators were constantly scrutinizing every aspect of the failed banks’ operations.  For example, Sun Security Bank of Ellington, MO, cited above, had been operating under stringent FDIC enforcement orders since April 2008.

It stands to reason that with regulators breathing down their necks, management of banks like Sun Security had would been valuing asset strictly in accordance with the law.  Yet in spite of this, Sun Security’s valuations turned out to have been overstated by 107%.

That suggests Sun Security’s 107% overvaluation, the other examples cited above ranging from 56% to 126% and the average, across-the-board overvaluations of 47% were all permissible under present accounting standards.

These facts indicate that regardless of statements made by politicians or Federal Reserve officials, there will be no end to Quantitative Easing or massive liquidity injections any time in the foreseeable future.  Any so-called recovery in the financial sector over the past several years appears to have been little more than an accounting trick permitted by the FASB’s elimination of fair value requirements.

Respectfully yours,

Richard Belfanti
“CIGA Richard B.”